Thus far, with the first three parts of this five-part series, we have examined 60% (18) of the 30 stocks in the Dow Jones Industrial Average (DJIA). So far, we have found the majority of these constituents are overvalued or at least fully valued. In part four, we will examine six additional Dow constituents that appear fairly valued with blended price-earnings (P/E) ratios of 14 to 16.
But as the title of this article asks, why are these six Dow stocks trading within the historical normal valuation range of the market when the others are being valued much higher? In other words, are they cheaper for a good reason?
Portfolio review: Six fairly valued stocks in the DJIA
The following portfolio review lists six stocks in the DJIA that appear fairly valued based on their current blended P/E ratio. There are many ways to value a stock in addition to the P/E ratio. Consequently, I suggest the readers also notice the price to cash flow of each of these six Dow constituents. For those investors most interested in dividend income, price to cash flow might be more relevant for higher-yielding, dividend-paying stocks. Furthermore, when ascertaining valuation, other factors such as expected growth need to be considered as well. I will elaborate more fully in the video below.
The following portfolio review is presented in order of highest blended P/E ratio to lowest. As an additional valuation check, note the earnings yield (EPS yield) of each of these Dow constituents is above 6%, but only three of the six are above my 6.5% to 7% threshold. Consequently, this particular group of stocks is more attractively valued than we have seen in previous parts of this five-part series. On the other hand, these six Dow stocks are not necessarily bargains at current levels either.
FAST Graphs analyze-out-loud valuation analysis
This video will present a quick overview of each of these Dow constituents based primarily on price relative to earnings and cash flow. For certain constituents, I will also evaluate other metrics. For any reader concerned with the current valuation of the stock market, this video and the videos in parts one, two and three – as well as the next and final video that will follow in part five – are necessary to watch. Furthermore, although I will be providing only a cursory due diligence analysis, you will find the video enlightening and, hopefully, entertaining.
Summary and conclusions
We have now reviewed 80% (24 of 30) of the Dow Jones constituents. From my perspective, what we have discovered is an index that is richly valued relative to fundamentals. On the other hand, there are only a handful of Dow stocks that might be considered dangerously overvalued. All of the dangerously overvalued constituents were found in parts one and two of this series. As we have progressively moved through the Dow constituents, the valuations were more in line with sound fundamental value. In this part, we saw three constituents that appear fairly valued with the other three only moderately overvalued relative to fundamentals.
These valuation statements do not simultaneously imply these stocks are great investments. In addition to fair valuation, investors must also consider the prospects for each individual company’s future growth potential. You can have two individual companies trading at similar P/E ratios that provide significantly different potentials for future returns. In other words, the company with the highest potential growth will be the better long-term investment in spite of similar current valuations. Current yield and dividend growth potential will also make a difference. Income investors might prefer the higher yield while total return investors might prefer higher growth potential.
In part five, I will be reviewing the following Dow stocks: Cisco Systems Inc. (CSCO, Financial), DuPont Inc. (DD, Financial), Goldman Sachs Group Inc. (GS, Financial), International Business Machines (IBM, Financial), Intel Corp. (INTC, Financial) and Verizon Communications Inc. (VZ, Financial).
For the reader’s convenience, here is a link to Part 1-The 6 Most Expensive Stocks, Part 2-6 More Expensive Stocks and Part 3-Are These the 6 Best Stocks?
Disclosure: Long General Electric, Pfizer at the time of writing.
Disclaimer: The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue, and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment adviser as to the suitability of such investments for his specific situation.
